Ahead of the credit policy, the ‘public’ consensus is that the Reserve Bank of India (RBI) will make a policy rate cut and perhaps slash cash reserve ratio (CRR) as well. The RBI has to balance off considerations of enabling growth versus controlling inflation. It has only monetary tools at its command.
The Budget implies that the government is reluctant to use its fiscal levers by initiating policy changes. In addition, the Budget commits the RBI to carrying out a massive borrowing programme to fund the fiscal deficit. This could be the biggest factor influencing RBI stance. Cynically, it would be best to fund the deficit as cheap as possible by cutting rates. So, it is a factor in favour of a rate cut.
One major problem in making a call is the unreliable data. All the relevant data is flawed. Indian inflation is tracked via the wholesale price index (WPI) rather than the consumer price index (CPI). Both indices have problems with construction and debatable weights. Both rely on tardy, and often wrong, data reportage.
For what it’s worth, both indices suggest that inflation is still way above target levels although it has dropped. In addition to the WPI and CPI, the RBI also calculates core inflation, tracking price levels in items others than food and energy. Crisil offers an alternative calculation of core inflation.
Core inflation is used as a measure of expectations. The logic is, food and energy are volatile in price. But rising prices of non-food and non-energy items reflect expectations. Core inflation seems to mirror WPI and CPI at the moment.
It is too high for comfort but off peak levels. The RBI has been notably hawkish. It may well decide that it has to maintain that stance of high rates until core inflation falls further, indicating inflationary expectations have been destroyed.
The other angle is enabling growth. India has been in a growth recession for several quarters. GDP estimates have been slashed. Corporate results show falling profits and lower margins. High interest rates have been at least partially responsible for lower growth.
Again, the data are extremely unreliable. A cursory look at indicators such as the Index of Industrial Production, GDP estimates, trade data, and so on, show that each and every one of those series is based on flawed data. There are always big differences in preliminary, revised and final estimates.
There are multiple, huge errors. Trade data for example, overstated exports by $9 billion between April-November 2011 and the January IIP provisional estimate was based on sugar production of 13 million tonne, and later corrected to 6 million tonne. It’s difficult to trust statistics based on such dodgy data collection. If we assume revised estimates are more reliable, there is a problem of timeliness. Those numbers are often released months later.
If we believe the IIP numbers, February (4.1 per cent year-on-year) has shown some growth over January (1.1 per cent after the correction of sugar production). But the IIP is still pretty low.
Budgetary estimates suggest that the government hopes GDP growth will pick up in 2012-13. However, the history of budgetary estimates and revisions suggests that the government is usually wrong by a significant degree in its budgetary estimates.
Effectively, if the data are unreliable, there is no clear monetary policy direction one can draw. Growth is down, inflation is high but lower than it was a few months ago. But the data are so messed up, one cannot model it to make a call on what will happen if rates are cut or held. At best, one can rule out the possibility that hiking rates will do much good.
What does the market expect RBI to do? There has been a drop in bond yields in the past two sessions. This could indicate expectations of a rate cut. However, yield curves are still tight, and inverted at some points.
In my opinion, it doesn’t matter for an investor. It would take a huge rate cut to make a concrete difference to corporate and the RBI doesn’t make huge cuts. A 25 basis-point cut would just take the market up a bit. But Q1, 2012-13 results would be unaffected. It would take a bigger cut—perhaps 75 bps or 100 bps to put some zing back into economic activity.
A small rate cut will therefore, create a bull trap. It could take the market up a bit and then there’ll be a fall once it’s recognised as ineffective. No cut will simply see the market heading south anyway. Things would get really interesting only if there’s a big rate cut and that’s very unlikely.